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The surprise but welcome rate cut by the European Central Bank (ECB) has improved the climate for equities, says Robeco’s portfolio manager for Global Allocations.
The rally in share prices driven by extra liquidity from monetary easing throughout this year is likely to continue, Lukas Daalder believes.
As a result, Robeco Asset Allocation has increased its overweight position to equities. At the same time, underweight positions in government bonds have been raised, as lower rates means reduced yields on sovereign debt, Daalder says.
The rate cut also made the euro drop in value by more than a cent against the US dollar. The asset allocation team has now opened up a short position on the EUR/USD, essentially predicting that the single European currency will fall further in value.
‘The global currency war is in full swing and the ECB just added a bit of artillery’
Liquidity-driven rally to continue
“We expect the current liquidity-driven rally in equities to continue for several months,” says Daalder. “We have become more constructive on equities as major risks have diminished while excess liquidity will remain around for longer.”
Some perceived risk factors that were seen as a threat to stock prices include the US government shutdown, which in the end did not endanger the US and global recovery. However, it did distort the macro data, shifting market expectations for the end of quantitative easing to the first quarter of 2014, leaving more excess liquidity around for longer in the economy.
The picture is less rosy for government debt, however, at least in the near term, says Daalder. “The ECB rate cut has pushed bond yields lower, but we don’t think this will be the case in the near term. We expect yields to gradually normalize from here,” he says.
Global growth is picking up
“Economic growth is picking up globally and, although the US Federal Reserve (Fed) has postponed tapering for now, it will probably start reducing its bond-buying program in the first quarter of next year. Then, the strong downward pressure on bond yields that we have seen over the last couple of years will start to end.
“And with the latest rate cut by the ECB we think yields have been pushed to the lower end of the range and will start to rise from here.”
Shorting the euro makes sense for now, says Daalder. “The ECB rate cut can be viewed as an instrument to fight the natural forces that drive up the euro like the positive current account surplus, the shrinking central bank balance sheet and disinflationary trends,” he says.
“With US tapering only postponed until next year and certainly not cancelled, we expect the US dollar to strengthen against the euro. The global currency war is in full swing and the ECB just added a bit of artillery.”
As base rates have lowered, the portfolio manager says high yield bonds remain the most attractive asset class, particularly as spreads against benchmark German bunds have dropped further below their long-term average. This makes them less risky, especially as default rates remain low, while returns remain strong.
European equities favored
Within equities, the asset allocation team has become less constructive on North America as earnings revisions have deteriorated. “Europe looks currently more favorable to us as the improved macro data has not been fully translated into relative equity performance, and of course the ECB rate cut will help share prices further,” says Daalder. “From a macroeconomic point of view, the delay in tapering should be positive for cyclical stocks.”
Among other asset classes, the team is neutral on emerging market debt and commodities, and negative on real estate, due to its sensitivity to interest rates.
Changes to Robeco’s multi-asset model portfolio: